Earnings Dispersion and Aggregate Stock Returns

Tepper School of Business Carnegie Mellon University Year 2009 Earnings Dispersion and Aggregate Stock Returns Bjorn N. Jorgensen Jing Li Gil Sadka University of Colorado at Boulder Carnegie Mellon University, jlill@andrew.cmu.edu Columbia University This paper is posted at Research Showcase. http://repository.cmu.edu/tepper/242

Electronic copy available at: http://ssrn.com/abstract=1323925

Electronic copy available at: http://ssrn.com/abstract=1323925

Figure 1a Aggregated Annual Returns, 1951-2005 0.8 Rt_ew Rt_vw 0.6 0.4 0.2 0 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003-0.2-0.4 Figure 1b Aggregated Annual Earnings Change, 1951-2005 0.05 0.04 Xt /Pt-1_ew Xt /Pt-1_vw 0.03 0.02 0.01 0 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003-0.01-0.02-0.03 This figure plots the time series average return and earnings changes for all firms from 1951 to 2005. X t /P t-1 _ew and X t /P t-1 _vw are the average deflated change in earnings which is defined as the ratio of change in earnings before extraordinary items from fiscal year t-1 to fiscal year t, deflated by the stock price at the beginning of fiscal year t. R t _ew and R t _vw are equal-weighted and value-weighted returns, calculated as cumulative market return from April of year t until March of year t+1. 26

Figure 2a Raw Dispersion of Earnings Change ( t ), 1951-2005 0.12 0.1 0.08 0.06 0.04 0.02 0 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 Figure 2b Dispersion of Earnings Change (DISP t ), 1954-2005 0.035 0.025 0.015 0.005 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002-0.005-0.015-0.025-0.035 Figure 2a plots the time series of raw dispersion of earnings change and Figure 2b presents its de-trended time series. The raw dispersion, t, is the dispersion of earnings changes. Earnings changes are scaled by beginning period market value, that is, X t / P t 1 for all sample firms in year t. DISP t is the estimated residual, t, from the regression: t t D t t t, where 0 1 2 1973 1 1 2 2 3 3 t D is a dummy 1973 variable equal to 1 for years after 1973, and 0 otherwise. The scales of the left and right vertical axes are for equal-weighted and value-weighted values, respectively. 27

0.12 0.1 st_ew t Figure 3 Raw Dispersion of Earnings and Coefficient of Negative Returns in Basu (1997) Coeff_ 0.45 0.4 0.35 0.08 0.3 0.06 0.25 0.2 0.04 0.15 0.02 0.1 0.05 0 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 0 Figure 3 plots the time series equal-weighted raw dispersion and the slope coefficient of earnings on negative return in Basu (1997). The raw dispersion, t, is the standard deviation of earnings change per share ( X t /P t-1 ) for all sample firms in year t. We estimate 1 from the following 1 regression X j, t / P j, t 1 0 1 DRj, t 1 Rj, t 2 DRj, t * Rj, t, where j, t X j, t / P is market-adjusted j, t 1 earnings deflated by the price at the beginning of fiscal year t, R, is the market-adjusted return for firm j in year t, and DR, is a dummy variable for negative return firm-year observations. j t The scale of the left vertical axis is for t, and scale of the right vertical axis is for the Basu coefficient, 1. 1 j t 28

Table 1 Descriptive Statistics This table reports the descriptive statistics for aggregate stock returns, earnings changes, earnings dispersion, and unemployment from 1951 to 2005. Return is the cumulative market return from April of year t until March of year t+1. R t _ew and R t _vw are equal-weighted and value-weighted returns of our sample firms, respectively. CRSPvw t is the CRSP value weighted return accumulated from April of year t until March of year t+1. X t /P t-1 is the average change in income before extraordinary items in fiscal year t from fiscal year t-1, deflated by the market value at the beginning of period t. t is the standard deviation of equal-weighted earnings changes per share ( X t /P t-1 ) for all sample firms in year t. The value-weighted measures use the market value at the beginning of fiscal year t as the weight. DISP t is the de-trended dispersion (standard deviation) of earnings changes in year t. We exclude data for firms with non-december fiscal year-end for 1954-2005, stock price below $1, and the top and bottom 5% of firms ranked by X t /P t-1 and the weight variables. Returns Average Earnings Earnings Dispersion R t _ew R t _vw CRSPvw t X t /P t-1 _ew X t /P t -1 _vw DISP t Mean 0.159 0.142 0.126 0.006 0.004 0.000 Std.dev 0.201 0.167 0.171 0.012 0.010 0.010 Median 0.131 0.124 0.127 0.006 0.005-0.002 Min. -0.185-0.188-0.258-0.023-0.021-0.016 Max. 0.790 0.548 0.470 0.043 0.026 0.031 29

Table 2 Correlation Matrix This table reports the correlations among time series returns, earnings changes, and earnings dispersion. Return is the cumulative market return from April of year t until March of year t+1. R t _ew and R t _vw are equal-weighted and value-weighted returns, respectively. CRSPvw t is the CRSP value weighted return accumulated from April of year t until March of year t+1. X t /P t-1 is the average change in earnings before extraordinary items in fiscal year t from fiscal year t-1, deflated by the market value at the beginning of period t. t is the standard deviation of scaled earnings changes ( X t /P t-1 ) for all sample firms in year t. The value-weighted measures use the market value at the beginning of fiscal year t as the weight. DISP t is the de-trended dispersion of earnings change in year t, respectively. The data covers 1954-2005. We exclude firm-years with non-december fiscal year-end, stock price below $1, and the top and bottom 5% of firms ranked for each year by X t /P t-1 and the weight variables. p-value of Pearson correlation is reported in parenthesis. Panel A: Correlation between contemporaneous returns and earnings measures R t _ew R t _vw CRSPvw t X t /P t-1 _ew X t /P t-1 _vw DISP t R t _ew 1 R t _vw 0.970 1 (0.000) CRSPvw t 0.851 0.931 1 (0.000) (0.000) X t /P t-1 _ew -0.170-0.210-0.238 1 (-0.215) (-0.124) (-0.089) X t /P t-1 _vw -0.191-0.218-0.227 0.957 1 (-0.161) (-0.110) (-0.105) (0.000) DISP t 0.345 0.291 0.184-0.295-0.380 1 (0.012) (0.036) (0.192) (-0.034) (-0.005) Panel B: Correlation between lagged returns and earnings measures R t-1 _ew R t-1 _vw CRSPvw t-1 X t /P t-1 _ew X t /P t-1 _vw DISP t R t-1 _ew 1 0.970 0.851 0.295 0.261-0.535 (0.000) (0.000) (0.031) (0.057) (-0.000) R t-1 _vw 1 0.931 0.223 0.188-0.513 (0.000) (0.104) (0.172) (-0.000) CRSPvw t-1 1 0.229 0.231-0.554 (0.102) (0.099) (-0.000) Panel C: Correlation between forwarded returns and earnings measures R t+1 _ew R t+1 _vw CRSPvw t+1 X t /P t-1 _ew X t /P t-1 _vw DISP t R t+1 _ew 1 0.970 0.851 0.183 0.193-0.190 (0.000) (0.000) (0.184) (0.161) (-0.182) R t+1 _vw 1 0.931 0.176 0.203-0.172 (0.000) (0.204) (0.140) (-0.227) CRSPvw t+1 1 0.122 0.186-0.260 (0.387) (0.188) (-0.062) 30

Table 3 Earnings Dispersion and Contemporaneous Stock Returns This table reports time series regression results for contemporaneous stock returns. The dependent variables are equal-weighted (R t _ew ) and value-weighted (R t _vw) returns in year t. These returns are measured from April of year t to March of year t+1. CRSPvw t is the CRSP value weighted return accumulated from April of year t until March of year t+1. The independent variables are aggregate earnings changes and earnings dispersion measures. X t /P t-1 _ew and X t /P t-1 _vw are the equal-weighted and value-weighted average changes in earnings before extraordinary items from fiscal year t-1 to fiscal year t, deflated by the market value at the beginning of period t. DISP t is the de-trended dispersion of earnings changes. The data covers 1954-2005. We exclude firm-years with non-december fiscal year-end, stock price below $1, and the top and bottom 5% of firms ranked for each year by X t /P t-1 and the weight variables. t-statistic with Newey-West standard errors is reported in parenthesis. Panel A: Equal-weighted contemporaneous return regressions Dependent variable: R t _ew Intercept 0.177 0.168 0.179 0.168 (6.58) (5.16) (6.92) (5.31) X t /P t-1 _ew -2.541-1.199 (-1.00) (-0.43) X t /P t-1 _vw -4.010-1.659 (-1.36) (-0.44) DISP t 6.677 6.453 (2.59) (2.17) AdjR 2 0.003 0.091 0.018 0.092 Panel B: Value-weighted contemporaneous return regressions Dependent variable: R t _vw Intercept 0.161 0.156 0.160 0.154 (6.76) (5.73) (6.92) (5.76) X t /P t-1 _ew -2.842-2.090 (-1.45) (-0.99) X t /P t-1 _vw -3.678-2.395 (-1.50) (-0.82) DISP t 3.742 3.520 (2.05) (1.70) AdjR 2 0.022 0.048 0.027 0.052 Panel C: CRSP value weighted contemporaneous return regressions Dependent variable: CRSPvw t Intercept 0.147 0.144 0.144 0.141 (5.37) (4.76) (5.32) (4.65) X t /P t-1 _ew -3.331-2.882 (-1.78) (-1.44) X t /P t-1 _vw -3.902-3.185 (-1.60) (-1.12) DISP t 2.234 1.968 (1.17) (0.92) AdjR 2 0.038 0.036 0.033 0.026 31

Table 4 Earnings Dispersion and Lagged Stock Returns This table reports time series regression results for one year lagged returns. The dependent variables are equal-weighted (R t-1 _ew) and value-weighted (R t-1 _vw) returns in year t-1. CRSPvw t-1 is the CRSP value weighted accumulated return in year t-1. These returns are measured from April of year t-1 to March of year t. The independent variables are earnings change and dispersion measures. X t /P t-1 _ew and X t /P t-1 _vw are the equal-weighted and value-weighted average change in earnings before extraordinary items from fiscal year t-1 to fiscal year t, deflated by the market value at the beginning of period t. DISP t is the de-trended dispersion of earnings changes. The data covers 1954-2005. We exclude firm-years with non- December fiscal year-end, stock price below $1, and the top and bottom 5% of firms ranked for each year by X t /P t-1 and the weight variables. The t-statistic with Newey-West standard errors is reported in parenthesis. Panel A: Equal-weighted one year lagged return regressions Dependent variable: R t-1 _ew Intercept 0.127 0.139 0.131 0.148 (3.10) (6.82) (6.43) (7.55) X t /P t-1 _ew 4.925 2.917 (3.10) (1.86) X t /P t-1 _vw 5.847 2.177 (2.47) (0.90) DISP t -9.988-10.076 (-4.19) (-4.46) AdjR 2 0.067 0.290 0.061 0.271 Panel B: Value-weighted one year lagged return regressions Dependent variable: R t-1 _vw Intercept 0.121 0.132 0.124 0.138 (5.95) (6.97) (6.37) (7.62) X t /P t-1 _ew 3.054 1.364 (1.88) (0.87) X t/p t-1 _vw 3.702 0.567 (1.77) (0.27) DISP t -8.411-8.606 (-4.13) (-4.49) AdjR 2 0.029 0.253 0.028 0.261 Panel C: CRSP value weighted lagged return regressions Dependent variable: CRSPvw t-1 Intercept 0.105 0.116 0.107 0.122 (4.24) (5.90) (4.26)) (6.21) X t /P t-1 _ew 3.203 1.434 (1.76) (0.89) X t/p t-1 _vw 3.965 0.695 (1.63) (0.31) DISP t -8.804-8.975 (-3.39) (-3.69) AdjR 2 0.034 0.289 0.034 0.281 32

Table 5 Earnings Dispersion and Lead Stock Returns This table reports time series regression results for one year lead returns. The dependent variables are equal-weighted (R t+1 _ew) and value-weighted (R t+1 _vw) returns in year t+1. CRSPvw t-1 is the CRSP value weighted accumulated return in year t+1. The independent variables are earnings change and dispersion measures. X t /P t-1 _ew and X t /P t-1 _vw are the equal-weighted and value-weighted average change in earnings before extraordinary items from fiscal year t-1 to fiscal year t, deflated by the market value at the beginning of period t. DISP t is the de-trended dispersion of earnings changes. The data covers 1954-2005. We exclude firm-years with non-december fiscal year-end, stock price below $1, and the top and bottom 5% of firms ranked for each year by X t /P t-1 and the weight variables. The t-statistic with Newey-West standard errors is reported in parenthesis. Panel A: Equal-weighted one year forwarded return regressions Dependent variable: R t+1 _ew Intercept 0.136 0.141 0.137 0.142 (7.08) (7.16) (6.84) (6.90) X t /P t-1 _ew 3.032 2.418 (1.57) (1.18) X t /P t-1 _vw 4.002 3.027 (1.67) (1.14) DISP t -3.069-2.736 (-1.53) (-1.31) AdjR 2 0.014 0.016 0.019 0.015 Panel B: Value-weighted one year forwarded return regressions Dependent variable: R t+1 _vw Intercept 0.123 0.127 0.122 0.126 (7.15) (7.42) (6.92) (7.22) X t /P t-1 _ew 2.292 1.770 (1.15) (0.87) X t/p t-1 _vw 3.583 2.813 (1.54) (1.18) DISP t -2.611-2.161 (-1.35) (-1.12) AdjR 2 0.008 0.012 0.026 0.021 Panel C: CRSP value weighted forward return regressions Dependent variable: CRSPvw t+1 Intercept 0.110 0.115 0.106 0.112 (4.85) (5.47) (4.80) (5.46) X t /P t-1 _ew 1.665 0.867 (0.86) (0.44) X t/p t-1 _vw 3.104 1.790 (1.44) (0.77) DISP t -3.970-3.606 (-1.97) (-1.72) AdjR 2-0.005 0.034 0.015 0.040 33

Table 6 Earnings Dispersion and Contemporaneous Return: Control for Macro Variables This table reports time series regression results for contemporaneous stock returns, after controlling for various macro variables. The earnings and return measures are defined as in Table 3. D_rec t is the dummy variable which equals 1 if year t is in the recession period based on the NBER definition. cay t is the consumption to wealth ratio as in Lettau and Ludvigson (2001), available from 1954 to 2001. s w t is the labor income to consumption ration as in Santos and Veronesi (2006), available from 1954 to 2001. GDP t is the de-trended shock in GDP growth rate in year t. PROD t is the de-trended shock in the growth rate of industrial production in year t. INF t is the de-trended shock in the inflation rate in year t. U t is the de-trended shock in the unemployment shock in year t. MVOL t is the unexpected market volatility measured following French, Schwert and Stambaugh (1987). The t-statistic with Newey-West standard errors is reported in parenthesis. #Obs is the number of observations used in each regression. Panel A: Equal-weighted contemporaneous return regressions 34 Dependent variable: R t _ew Intercept 0.183 0.168 0.433 0.156 0.172 0.168 0.148 0.172 0.577 0.702 (5.83) (5.42) (0.67) (5.64) (5.29) (5.31) (5.98) (5.550) (1.06) (1.02) X t /P t-1 _ew -1.850-2.747-2.590 0.656-1.852-1.191 1.535-2.512-1.550-1.147 (-0.62) (-1.01) (-0.91) (0.27) (-0.60) (-0.42) (0.67) (-1.00) (-0.61) (-0.47) DISP t 7.036 4.680 4.810 5.512 6.724 6.665 4.947 6.128 1.827 (2.67) (2.07) (2.09) (2.08) (2.50) (2.56) (1.84) (2.43) (0.68) D_rec t -0.035-0.063-0.077 (-0.47) (-0.71) (-1.08) cay t -0.459-2.103-2.115 (-0.28) (1.20) (-1.09) s w t -0.322-0.505-0.654 (-0.40) (-0.78) (-0.79) GDP t -2.013 2.162 2.302 (-1.32) (2.54) (1.87) PROD t 0.413 1.413 1.276 (0.75) (1.98) (1.55) INF t 0.148 0.898 0.798 (0.07) (0.75) (0.49) U t 0.078 0.221 0.222 (1.97) (4.55) (4.55) MVOL t -1.617-1.159-1.087 (-3.46) (-3.55) (-3.07) Adj.R 2 0.076 0.060 0.062 0.100 0.080 0.072 0.135 0.215 0.334 0.324 #Obs 52 48 48 52 52 52 52 52 48 48

Panel B: Equal-weighted contemporaneous return regressions Dependent variable: R t _vw Intercept 0.166 0.155 0.305 0.147 0.157 0.154 0.138 0.156 0.502 0.500 (5.05) (5.42) (0.53) (6.05) (5.84) (5.80) (6.52) (6.05) (1.03) (0.82) X t /P t-1 _vw -3.099-4.008-3.863-0.983-3.155-2.390 0.351-3.659-3.124-3.135 (-0.88) (-1.50) (-1.35) (-0.33) (-1.01) (-0.81) (0.12) (-1.45) (-1.19) (-1.11) DISP t 3.740 2.142 2.302 2.906 3.504 3.528 2.376 2.940-0.030 (1.86) (1.06) (1.05) (1.37) (1.62) (1.66) (1.11) (1.51) (-0.01) D_rec t -0.029-0.069-0.068 (-0.48) (-0.87) (-1.21) cay t 0.276-0.858-0.857 (0.26) (-0.86) (-0.69) s w t -0.183-0.421-0.419 (-0.26) (-0.72) (-0.57) GDP t -1.303 3.117 3.115 (-1.03) (2.51) (1.88) PROD t 0.437 1.232 1.234 (0.89) (1.96) (1.71) INF t -0.059 0.539 0.542 (-0.03) (0.50) (0.31) U t 0.065 0.210 0.210 (1.93) (4.48) (4.26) MVOL t -1.378-0.875-0.814 (-3.53) (-3.56) (-2.73) Adj.R 2 0.076 0.060 0.062 0.046 0.042 0.028 0.135 0.181 0.343 0.325 #Obs 52 48 48 52 52 52 52 52 48 48 35

Panel C: CRSP value-weighted contemporaneous return regressions Dependent variable: CRSP t _vw Intercept 0.160 0.145 0.432 0.136 0.147 0.141 0.127 0.143 0.623 0.525 (3.71) (5.29) (0.75) (4.59) (4.94) (4.69) (4.40) (5.03) (1.17) (0.85) X t /P t-1 _vw -4.309-4.221-3.957-2.204-4.621-3.138-0.807-4.482-3.179-3.750 (-1.14) (-1.48) (-1.29) (-0.73) (-1.55) (-1.12) (-0.26) (-1.79) (-1.45) (-1.28) DISP t 2.319 0.822 1.104 1.541 1.938 2.043 0.977 1.372-1.502 (1.23) (0.35) (0.44) (0.72) (0.91) (0.96) (0.45) (0.65) (-0.58) D_rec t -0.047-0.094-0.084 (-0.71) (-1.40) (-1.31) cay t 0.373-0.601-0.567 (0.36) (-0.55) (-0.52) s w t -0.352-0.571-0.453 (-0.49) (-0.89) (-0.61) GDP t -0.906 2.615 2.516 (-0.78) (1.37) (1.31) PROD t 0.826 1.429 1.542 (1.57) (2.07) (1.95) INF t -0.601 0.205 0.332 (-0.33) (0.14) (0.21) U t 0.056 0.207 0.207 (1.67) (3.77) (3.80) MVOL t -1.414-0.756-0.812 (-3.29) (-2.37) (-2.20) Adj.R 2 0.017 0.016 0.020 0.014 0.056 0.009 0.055 0.167 0.350 0.339 #Obs 52 48 48 52 52 52 52 52 48 48 36

Table 7 Earnings Dispersion and Lagged Return: Control for Macro Variables This table reports time series regression results for lagged stock returns, after controlling for various macro variables. The earnings and return measures are defined as in Table 4. D_rec t is the dummy variable which equals 1 if year t is in the recession period based on the NBER definition. cay t is the consumption to wealth ratio as in Lettau and Ludvigson (2001), available from 1954 to 2001. s w t is the labor income to consumption ration as in Santos and Veronesi (2006), available from 1954 to 2001. GDP t is the de-trended shock in GDP growth rate in year t. PROD t is the de-trended shock in the growth rate of industrial production in year t. INF t is the de-trended shock in the inflation rate in year t. U t is the de-trended shock in the unemployment shock in year t. MVOL t is the unexpected market volatility measured following French, Schwert and Stambaugh (1987). The t-statistic with Newey-West standard errors is reported in parenthesis. #Obs is the number of observations used in each regression. Panel A: Equal-weighted lagged return regressions Dependent variable: R t-1 _ew Intercept 0.155 0.136 0.382 0.146 0.146 0.146 0.162 0.140 0.228-0.319 (4.94) (6.89) (0.79) (7.14) (6.74) (7.63) (7.36) (6.89) (0.34) (-0.55) X t /P t-1 _ew 2.226 2.894 3.095 1.927 1.976 2.649 0.629 2.613 3.906 2.147 (1.03) (1.60) (1.64) (1.09) (1.21) (1.66) (0.39) (1.69) (1.54) (0.84) DISP t -9.607-8.618-8.398-9.366-9.917-9.621-8.540-10.116-7.984 (-3.70) (-3.42) (-3.31) (-3.57) (-4.16) (-3.73) (-3.27) (-4.33) (-2.73) D_rec t -0.037-0.004 0.059 (-0.58) (-0.03) (0.68) cay t 0.241 0.740 0.795 (0.20) (0.37) (0.44) s w t -0.302-0.097 0.553 (-0.51) (-0.12) (0.79) GDP t 1.074-1.846-2.456 (0.93) (-0.85) (-1.06) PROD t 0.602-0.800-0.198 (1.24) (-1.37) (-0.42) INF t -4.526-4.680-4.243 (-3.84) (-2.59) (-2.80) U t -0.065-0.116-0.118 (-3.04) (-1.97) (-1.89) MVOL t -0.375 0.360 0.049 (-0.68) (0.62) (0.09) Adj.R 2 0.280 0.243 0.246 0.284 0.293 0.428 0.320 0.283 0.237 0.367 #Obs 52 48 48 52 52 52 52 52 48 48 37

Panel B: Value-weighted lagged return regressions Dependent variable: R t-1 _vw Intercept 0.162 0.136 0.212 0.145 0.143 0.141 0.154 0.139 0.031-0.394 (5.17) (7.60) (0.47) (7.42) (7.09) (8.65) (7.29) (7.58) (0.06) (-0.84) X t /P t-1 _vw -0.797 0.725 0.7785-0.928-0.624 0.895-2.368 0.265 2.866 0.391 (-0.30) (0.31) (0.32) (-0.42) (-0.31) (0.42) (-1.16) (0.13) (0.79) (0.12) DISP t -8.180-7.395-7.336-7.954-8.631-8.086-7.383-8.744-6.518 (-3.85) (-3.61) (-3.49) (-3.89) (-4.65) (-3.81) (-3.54) (-4.67) (-2.65) D_rec t -0.057-0.006 0.037 (-1.03) (-0.06) (0.49) cay t -0.006 0.436 0.585 (-0.01) (0.26) (0.38) s w t -0.093 0.139 0.650 (-0.17) (0.25) (1.16) GDP t 1.380-2.315-2.751 (1.35) (-1.37) (-1.55) PROD t 0.685-0.657-0.164 (1.72) (-1.50) (-0.45) INF t -4.165-4.605-4.054 (-3.75) (-3.01) (-2.78) U t -0.069-0.114-0.118 (-3.15) (-2.37) (-2.19) MVOL t -0.329 0.369 0.127 (-0.76) (0.74) (0.27) Adj.R 2 0.254 0.186 0.188 0.258 0.272 0.427 0.302 0.246 0.248 0.360 #Obs 52 48 48 52 52 52 52 52 48 48 38

Panel C: CRSP value-weighted lagged return regressions Dependent variable: CRSP t-1 _vw Intercept 0.153 0.121 0.389 0.133 0.131 0.125 0.142 0.123 0.193-0.255 (4.96) (5.68) (0.85) (6.21) (6.22) (6.82) (6.04) (6.26) (0.37) (-0.58) X t /P t-1 _vw -1.038 1.630 1.691-1.579-1.176 0.985-2.805 0.524 3.385 0.776 (-0.41) (0.63) (0.64) (-0.68) (-0.59) (0.44) (-1.21) (0.24) (0.72) (0.20) DISP t -8.434-7.528-7.568-7.984-9.014-8.516-7.516-9.054-6.866 (-3.23) (-3.13) (-2.97) (-3.18) (-4.04) (-3.24) (-2.86) (-3.78) (-2.40) D_rec t -0.073-0.025 0.021 (-1.44) (-0.28) (0.29) cay t -1.604-0.933-0.779 (-1.64) (-0.64) (-0.58) s w t -0.323-0.067 0.470 (-0.57) (-0.11) (0.88) GDP t 2.099-2.529-2.986 (2.06) (-1.79) (-2.01) PROD t 1.076-0.339 0.179 (2.90) (-0.92) (0.48) INF t -3.676-3.917-3.333 (-3.03) (-2.55) (-2.26) U t -0.082-0.108-0.111 (-3.39) (-2.02) (-1.92) MVOL t -0.187 0.461 0.206 (-0.41) (0.93) (0.43) Adj.R 2 0.293 0.230 0.213 0.313 0.352 0.413 0.373 0.268 0.249 0.369 #Obs 52 48 48 52 52 52 52 52 48 48 39

Table 8 Contemporaneous and Lagged Returns Regressions: Controlling for Implied Market Volatility This table reports time series regression results for contemporaneous and lagged stock returns, controlling for implied market volatility. The earnings and return measures are defined as in Table 3 and 4. VIX t and VXO t are the annual average of CBOE Volatility Index under new methodology and old methodology respectively, where CBOE changed the methodology of calculating implied volatility in 2003. The new methodology measure starts from 1990. The old methodology measure starts from 1986. ). The t-statistic with Newey-West standard errors is reported in parenthesis. Panel A: Implied volatility with new methodology (1990-2005) Contemporaneous Return Lagged Return R t _ew R t _vw CRSPvw t R t-1 _ew R t-1 _vw CRSPvw t-1 Intercept 0.276 0.307 0.291 0.143 0.181 0.135 (1.15) (1.67) (1.64) (0.96) (1.74) (0.94) X t /P t-1 _ew 7.204-0.375 (2.10) (-0.13) X t /P t-1 _vw 4.289 1.354-3.240-3.186 (1.50) (0.43) (-1.21) (-0.89) DISP t 8.928 4.936 1.527-9.982-9.126-10.276 (2.19) (1.37) (0.33) (-2.47) (-3.16) (-2.56) VIX t -0.007-0.008-0.009 0.002-0.001 0.000 (-0.55) (-0.86) (-0.79) (0.24) (-0.23) (0.03) AdjR 2 0.129-0.032-0.170 0.154 0.290 0.365 #Obs 16 16 16 16 16 16 Panel B: Implied volatility with old methodology (1986-2005) Contemporaneous Return Lagged Return R t _ew R t _vw CRSPvw t R t-1 _ew R t-1 _vw CRSPvw t-1 Intercept 0.353 0.352 0.344 0.165 0.176 0.146 (1.93) (2.41) (2.29) (1.39) (2.33) (1.45) X t /P t-1 _ew 5.287-1.907 (1.61) (-0.63) X t /P t-1 _vw 2.579 0.809-4.121-3.943 (0.95) (0.29) (-2.08) (-1.29) DISP t 8.898 4.781 1.955-10.702-9.802-10.846 (1.85) (1.18) (0.42) (-2.87) (-3.53) (-2.85) VIX t -0.011-0.010-0.011 0.001 0.000 0.000 (-1.21) (-1.46) (-1.27) (0.10) (-0.06) (0.09) AdjR 2 0.143 0.029-0.051 0.220 0.339 0.398 #Obs 20 20 20 20 20 20 40